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Wednesday, July 23, 2014

US CPI Rises at 3.1 Percent Annual Rate in June. What Does That Mean? An Increase in the Cost of Living, or Inflation?

On Tuesday, the Bureau of Labor Statistics
announced that the US Consumer Price Index (CPI) rose Mike Bryanon the Atlanta Fed’s Macroblog has made me think again.
at a seasonally
adjusted annual rate of 3.13 percent in June. What does such a figure
really mean? Is it a measure of inflation or of the change in the cost
of living? Until recently, I would have answered that there was no
difference, but a recent series of posts by

What’s the difference?

As
Bryan explains it, the cost-of-living concept arises from the role of
money as a medium of exchange. When we say the cost of living increases,
we mean that it gets harder to maintain a given standard of living on a
given income. Either we have to be satisfied with fewer goods or
services, or save less, or work harder. In the language of economics, a
change in the cost of living is a real phenomenon.

On the
other hand, we can best understand inflation as a change in the value
of our unit of account, the dollar. When there is inflation, the value
of the unit is smaller each day than it was the day before, for all
transactions. This earlier post includes a chart showing how dramatically the value of our unit of account has changed over the past 100 years.

Imagine
that you woke up one morning to find that someone had chopped an inch
off all our rulers, so that today’s foot was now only as long as
yesterday’s eleven inches. You might go from being six feet tall to
six-foot-six, but it wouldn’t be any easier for you to reach the top
shelf in the kitchen without a footstool. Similarly, if inflation raises
both your income and the prices of everything you buy by the same
percentage, the value of a dollar as an economic ruler shrinks, but it
is neither harder nor easier to maintain the same real standard of
living. In that sense, inflation is a purely nominal phenomenon. >>>Read more

Follow this linkto view or download a brief slideshow with charts of the latest CPI data

2 comments:

I think there are two issues here. The first is the one posed of does a change in inflation affect the standard of living, which you addresses quite well that this depends on how net incomes change over the same period. The second question is how well does the current CPI calculation capture the actual change in prices of personal expenditures over time? Here I'm not so confident that the published CPI does such a good job. The current CPI is derived from a very complicated formula that has changed quite a bit since 1980.

It would be interesting to actually have a few dozen people track the change in prices for what they buy over a few years to see what actual changes occur for real people.

You raise a good point. We should never take a single source of price information at face value, including the CPI. You should check independent estimates that are derived from different data sets by different methods.

One such method is the deflator for personal consumption expenditures from the Bureau of Economic Analysis. It uses a completely different methodology than the CPI.

Another is the Billion Prices Project from MIT. It gets its prices from the Internet and has a much wider range of inputs compared with the CPI. You can see it here: http://bpp.mit.edu/

Both of these series track the CPI rather closely over a period of a year or two, but they can diverge significantly in any given month.

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